The Final State of Expatriation? - Part I

Section 301 of the Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART” or the “Act”) dramatically alters the playing field for individuals who relinquish their U.S. citizenship or terminate their long-term U.S. residence (i.e., U.S. persons who “expatriate”). It does this by adding new sections 877A and 2801 to the Code, which, respectively, impose “mark-to-market” and “succession tax” regimes on such individuals.

Prior to HEART’s enactment, expatriates generally were subject to a 10-year “alternative tax” regime on U.S.-source income, as defined, that was first introduced by the Foreign Investors Tax Act of 1966 (“FITA”). These rules were contained principally in sections 877, 2107 and 2501 of the Code.

In the intervening four decades, the alternative tax regime was modified twice, first by the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and then by the American Jobs Creation Act of 2004 (“AJCA”). Both of these Acts generally strengthened the income and transfer tax rules applicable to expatriates under the alternative tax regime.

However, despite these enhancements, the U.S. rules applicable to tax expatriation remained the subject of a continuing Congressional debate that began in 1995, when the Clinton administration proposed a somewhat radical “exit tax” regime as part of its fiscal 1996 Budget. The debate, which included claims calling the exit tax proposal a violation of international human rights, eventually focused on whether the tax opportunities and perceived abuses arising from expatriation can best be deterred or controlled through the alternative tax regime or whether an exit tax or mark-to-market regime would be more effective. The enactment of the HEART Act’s changes, which are generally effective from June 17, 2008, when President Bush signed the legislation into law, appears to indicate that, at least for the foreseeable future, the tax consequences of expatriation by U.S. persons will be governed by the mark-to-market and succession tax regimes.